Czech Republic Central Bank Statement

Author: | Published: 5 Sep 2017

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To better understand economic developments in the Czech
Republic in 2017 we need to return to 2013. At that time, the
Czech economy was languishing in the longest recession of
modern times, caused by a combination of economic contraction
abroad, a sharp drop in private investment and domestic budget
restrictions lasting several years. As a result, the Czech
economy was exposed to strong external and domestic
disinflation pressures, which were accompanied by falling
inflation expectations. The inflation forecasts at the time
were indicating a rising risk that the Czech National Bank's
(CNB) 2% inflation target would be significantly undershot
unless monetary conditions were eased further. The CNB had
already lowered its interest rates to zero back in November
2012, and its verbal interventions during 2013 had had only a
limited effect, so the central bank decided in November 2013 to
weaken the koruna to CZK27 to the euro and not allow it to
appreciate below that floor. This commitment was to be achieved
by making foreign exchange interventions without any volume
limits.

In the years that followed, the external disinflation
pressures turned out to be much stronger and longer lasting
than the CNB's end-2013 forecasts had suggested. The exchange
rate commitment was therefore prolonged several times. It was
not until late 2016 and early 2017 that core inflation
(especially imputed rent and cafe and restaurant prices)
started to rise significantly. It was joined by growth in food
and fuel prices. In September 2016, annual headline inflation
had been at 0.5%, but by March 2017 it had risen to 2.6%.
Constantly rising core inflation (running at 2.4% year on year
in April) had created conditions for sustainable fulfilment of
the inflation target even given the expected appreciation of
the koruna after the exit from the exchange rate commitment.
The CNB exited on April 6, not long after the end of the period
for which the commitment to maintain a weakened koruna had
applied. This was the first step towards normalising monetary
policy, i.e. towards using interest rates as the main
instrument again.

At the time of writing, less than two months had passed
since the CNB left the koruna to float on the market. The exit
can preliminarily be assessed as a success. It was performed in
a highly transparent way and fully in line with the CNB's
earlier communications. The volatility shown by the koruna so
far does not go beyond the usual market fluctuations. The Czech
currency is displaying a modest appreciation tendency (of
around 2% relative to the rate of CZK27 to the euro).

The CNB's analyses have repeatedly indicated that the
weakening of the koruna contributed significantly to the
recovery of the Czech economy that started in 2014, to the
creation of many new jobs in the economy, and to faster
fulfilment of the inflation target. The Czech economy is
currently operating at its potential output level. The labour
and property markets are even showing signs of overheating.
According to the CNB's May forecast, the economy will grow at a
rate of around 3% and inflation will fluctuate close to the
inflation target in 2017 and 2018. Consistent with the forecast
is an increase in domestic market interest rates in the third
quarter of 2017 and later also in 2018. The future path of the
koruna exchange rate is still the biggest uncertainty of the
forecast, especially given the market 'overboughtness' that
occurred in the last few months before the exit from the
exchange rate commitment. The condition of the Czech economy
can currently be assessed as very good overall, thanks in no
small measure to the actions of the CNB.